The development of outsourcing

In the 1990s, some management theorists argued that the important factor in maintaining competitiveness was differentiating between core and non-core functions and then transferring all non-core functions to a specialist in that function. This was not a particularly new idea but it was certainly one ’whose time had come’. As discussions on the subject increased and evolved, the concept of the virtual organization was born. The theory behind the virtual organization is that any function that is not core should be transferred to an external specialist in that function. In addition, however, it argues that there are bound to be organizations that will perform your core functions better than you do – so why not transfer those as well? A number of organizations have recently been created on this principle, i.e. all, or almost all, the functions have been outsourced from day one – leaving behind only the ’soul’ of the business. It is too soon to come to any conclusion as to the rights and wrongs of starting an enterprise this way. Nevertheless, it will be interesting to see what happens to them over the medium and long term.

It is now generally accepted that however a function or group of business processes is structured or managed, improvements done on a one-off basis are, at best, fire-fighting exercises. The ideal solution would involve putting each individual function or group of processes in a position where it is able to take up new technology developments when they first appear and to seek out continuous improvements, in order to remain competitive.

It is possible to lay down the necessary requirements for the function head to be able to achieve this aim.

• The function should, ideally, be core.

• The function should be capable of continuous growth in order to attract the best quality workers.

• The function should be in a position to grow by taking on additional clients.

There is a strong argument for saying that if management cannot make a case for the continuous growth of a function then they should strongly consider one or more of the externalization options.

The virtual organization concept may be very new, but externalizing functions to outside specialists has been practised for many years under various names: contract manufacturing, facilities management, outsourcing and insourcing. For example, many major firms of accountants will freely admit that even at the beginning of the twentieth century they had clients for whom they did the ’books’ rather than the audit, and this situation remains true today.

With hindsight ’externalizing’ might have been a better name than ’outsourcing’ to describe the range of business activities that have grown up on the basic business idea that if your organization does not specialize in a particular function, then it will probably be beneficial in terms of cost and quality of service to transfer the control of the function to a specialist organization.

Contract manufacturers and people involved in the facilities management business will generally agree that they are in an outsourcing business. However, when most people hear or see the word outsourcing they normally think of IT outsourcing.

The outsourcing of IT functions started to happen on a major scale because of the high cost of processing power in the 1970s. This situation forced even major organizations to get at least some of their computer solutions from computer bureaux. The realization that the enormous expense that they might only recently have incurred on hardware was not going to keep them competitive for very long was a defining factor in the move towards outsourcing.

Knowing that they had to maintain existing systems, yet invest further in the hardware, software and specialists necessary to move into expensive replacement systems concentrated the corporate mind. Senior management began to worry that their IT departments were taking an ever increasing share of time and resources and yet were not part of their core business. Given these circumstances, clients who had either cash flow problems, exceptionally poor systems, were suffering strong competition or who needed to relocate, initially dominated the outsourcing of IT.

The outsourcing boom was therefore born on the back of the IT area and the unique circumstances experienced in IT during the latter part of the twentieth century.

In those early days of outsourcing, the clients and their IT service providers would both anticipate that a specialist in IT would be able to provide at least a comparable level of service to that which existed before the transfer. Equally they would expect that the service provider could do this profitably whilst producing a saving for the client. Nevertheless, it is doubtful if too many people at the time could imagine the potential savings from an outsourcing arrangement.

The typical service provider will try to ensure that by the end of the transition, i.e. when the relevant staff are finally transferred to the service provider’s employment, all the initial changes deemed necessary to the system have been completed. The cost of providing the service from that point on is always going to be an unknown until it finally takes place. It is interesting to note, however, that most providers initially estimated that the likely savings would be something under 20 per cent, but gradually began to realize that even when apparently efficient IT departments were being transferred, the figure could reach 40 per cent or more. Obviously this figure will be shared in some way by both client and service provider.

When the outsourcing of finance departments first became a reality, new, would-be, service providers imagined that the total saving might be in the order of 15–20 per cent. Although actual results have varied enormously, total savings of 40 per cent have been achieved with this function also.

Many of the early outsourcing deals were disasters for one and sometimes both parties, and for a while it appeared that the lawyers were always going to be the greatest beneficiaries.

However, when the successful deals started to get publicity, it became apparent that there was a significant savings factor to be shared by both parties, if an efficient specialist service provider was involved and sufficiently motivated. Once this situation was understood, it became clear that outsourcing could not be ignored. How could it be, when articles appeared, endorsed by both parties to an outsourcing, which indicated it was possible for a client organization to obtain both an improved service and cost savings immediately after the transition and then look forward to further service improvements and savings in the future.

Consequently, outsourcing became a dominant feature of business in the 1990s with functions other than IT being outsourced. As the globalization of business increased and the World Wide Web began to evolve, the growth rate of all the externalization to outside specialist industries such as outsourcing and contract manufacturing took off at similar rates.

The important factor that cannot be ignored is that all functions are now being outsourced and the rate at which new contracts are being created is increasing all the time.

However, it is important to understand the various reasons why this growth is taking place. Certainly, there are still many clients signing outsourcing deals for the very reasons that started the modern boom in IT outsourcing. In other words, they have cash flow problems, need to relocate, or recognize that they have very poor, non-competitive systems.

A significant number of others have approached the situation from a very different angle. They have accepted the evidence put forward by a number of satisfied clients and their providers and reasoned that the service improvements, savings and, above all, continuous improvements claimed could only have been achieved by using external specialists. They have, therefore, approached the outsourcing concept with added value in mind and did so even where the relevant managers believed that they were already competitive with the functions concerned.